I warned in July that investing in junk bonds was like playing with fire. And boy are many investors getting burned now!

Just look at this chart of the SDPR Barclays High Yield Bond ETF (JNK). You can see that it started rolling over in June, then utterly collapsed in the past month! At around $40, JNK has given up every penny of gains it racked up in the last year!

What the heck happened? Why did junk tank, just like I feared it would? Several reasons …

First, the Federal Reserve is signaling a change in interest-rate policy. I don’t care what the mainstream Wall Street economists are saying. They were the same ones who said in 2013 that QE would last forever, even as I forecast it would soon go the way of the dodo. Now they’re telling you 0 percent rates will last forever, even as I believe they’ll disappear as soon as January.

Rising short-term rates will put pressure on the vulnerable, over-indebted companies whose debts make up the junk bond market. They’re also bad for almost all bonds, regardless of who is issuing them.

Second, the Fed’s biggest and most vocal hawk, Dallas Fed President Richard Fisher, warned of “extreme risk taking in the junk bond markets.” In his comments from a Rome conference, he also said rates will likely start rising sooner than Wall Street expects.

Why is this such a big deal? PIMCO runs the largest bond fund in the world, the $222 billion Pimco Total Return fund. It was already bleeding billions of dollars in assets, thanks to a combination of poor performance and investor concerns about executive stability.

Now that the highly visible Gross is leaving, even more assets may walk out the door. That could lead to large redemptions — and forced sales — of less-liquid junk bonds. And that would lead to even-lower bond prices across the board.

Bottom line? I thought junk bonds were wildly overvalued earlier this year, offering way too little yield to offset the risk involved with investing in these high-risk companies. I said they were much riskier investments for generating yield than, say, master limited partnerships. Now, they’ve torched investors with losses.

I know it’s tempting, given the lousy level of yields on safer corporate bonds and Treasuries. But if you don’t know what you’re buying, you can (and probably will!) lose money! Stick with MLPs, shorter-term, higher-grade corporate notes and the other, better alternatives I’ve been recommending.

So what do you think about the junk bond plunge here? Is it hurting your portfolio, or did you get out of the way already? Where do you think junk bonds will go next? Are they a bargain now … or still too risky? You can post your comments below, and I recommend you do so as soon as it’s practical for you!

Our Readers Speak

Are the markets in big trouble here, on the verge of a significant pullback? That’s a hot topic at the website right now, and you have differing opinions.

Reader Dave C. said he went to 40 percent cash three weeks ago, anticipating tough times. His comments: “The death cross in the Russell is significant. The small caps led on the way up over the last 5.5 years, and continue to lead; this time on the way down. Now that Alibaba is out of the way, GS has stopped supporting the Dow and S&P 500.

“The current market selloff, somewhat overdue, is anticipating the end of QE III and Fed stimulus. Without Fed stimulus, the deflation that grips Europe will take us down as well.”

Reader H.C.B. added words of caution, saying: “With everything that’s going on internationally and no one country in control, I would tend to ‘batten down the hatches’ now a little bit, just in case. You never know if a surprise awaits just around the corner.

“For example, commodities in general and precious metals (gold and silver) are now definitely back in a bear market of their own, as global growth is slowing down some more. I am beginning to wonder if we are not entering a global recession with Europe leading the way down. Time will tell. If so, stocks will reflect it sooner or later.”

But Reader Mike C. took a different tack, saying the U.S. will likely continue to benefit from turmoil overseas. His view: “Simply put, we are still the least ugly girl at the dance, and will continue in that status for a measurable period of time. The big money is flying to safety!”

Thanks for weighing in. You know that I’m a conservative investor by nature. But you’re also aware that I’ve been willing to ride the strong trends we’ve seen in select sectors over the past couple of years.

I recently made some additions and deletions in the Safe Money Report model portfolio because of the market developments we’re seeing. But I’m not running for the hills because my crash indicators aren’t flashing yellow or red at this time.

Finally, Reader Joe E. discussed a novel way we could put the screws to Vladimir Putin without getting involved in a shooting war. His idea: “We can’t let Putin and Russia put the strong arm on Europe like Stalin and Russia did after WW II. We need a new ‘Berlin Airlift.’ It seems we have a tremendous abundance of natural gas in N. America. Why not liquefy it and ship it to Europe and put an end to the threat of a ‘cold’ war cold winter?

“Yes, it will take it some time to gear up for this; however, the problems with Russia (and its threat to shut off supplies) are not going away anytime soon. Better to address it now, while time is on our side, than to wait until the situation becomes dire.”

Joe, that’s a great point. Whether we send more gas to Europe via ship … or whether new pipelines are built to send gas there from, say, the giant fields being discovered off the coast of Israel … the industry will hopefully find a solution to Russia’s supplier dominance eventually.

Feel free to add anything more on these or other topics below!

Other Developments of the Day

Who is the Khorasan group? What is left of al-Qaeda 13 years after the 9/11 attacks? Have other terrorist groups become much more relevant — and dangerous? This Washington Poststory provides some good insights and is worth a read.

Sure, stocks tanked earlier this week. But on the “panic” scale, the selling hasn’t been too bad (so far). This Bloomberg story notes that $320 billion in value was erased from U.S. stocks yesterday … but the “VIX” gauge of fear only rose to 15.6. That’s below every other panic peak since 2012.

Six major global banks are getting close to settling charges from the U.K.’s bank regulator that they manipulated the currency market. No precise cost has emerged yet. But each bank will likely pay more than the $261 million UBS (UBS, Weiss Ratings: B-) had to shell out in 2012 for a separate investigation into interest rate market shenanigans.

Unlimited vacation time? Now THAT’s a corporate policy I could get behind! It’s spreading in the technology world, including at companies like Netflix (NFLX, Weiss Ratings: C+), and this article from Business Insider explains some of its pros and cons.

Reminder: You can let me know what you think by putting your comments below.

Until next time,

Mike Larson

Mike Larson graduated from Boston University with a B.S. degree in Journalism and a B.A. degree in English in 1998, and went to work for Bankrate.com. There, he learned the mortgage and interest rates markets inside and out. Mike then joined Weiss Research in 2001. He is the editor of Safe Money Report. He is often quoted by the Washington Post, Reuters, Dow Jones Newswires, Orlando Sentinel, Palm Beach Post and Sun-Sentinel, and he has appeared on CNN, Bloomberg Television and CNBC.

{11 comments }

MarioFriday, September 26, 2014 at 6:28 pm

My wife works at a vitamin manufacturing facility and they sell their products around the world. She says that the immediate term orders has suddenly become very very lite and the company is encouraging employees to take time off. This recent change in orders has not been seen since shortly before the housing crisis peaked and the market tanked in 2008. I would strongly recommend caution in the equities markets, because there appears to be a decrease in production coming, and I’ll go so far as to say it is here now. I don’t know if the dollar’s strength is contributing to this and causing buyers to find their product elsewhere, but I don’t think this is the case only because I believe the buyers are looking for high quality products simply because most of these foreign buyers could have bought their products cheaper elsewhere (with less quality). So I’m thinking global recession could be in progress right now and it will start to feed into our economy over the next few months. Tax selling has a few more days to go and then we will see Octobers growth projections. I have a strong feeling we are in for a whopper bear market for a few quarters at least.

Rob JonesSaturday, September 27, 2014 at 5:49 am

Some of these personal insights could be very valuable.

tim zampFriday, September 26, 2014 at 7:55 pm

buy… SJB… short… JUNK BONDS

eric siversonFriday, September 26, 2014 at 9:32 pm

I don’t think Russia has done anything wrong , But we have by encouraging Ukraine to skip out on paying their last winters gas bill and granting them 5 billion dollars to raise hell with Russia . We have not been supporting very nice people in Ukraine or Syria . In Ukraine we are supporting real old fashion NAZI’s While in Syria we supported the liver eaters and ISIS . In Ukraine it was discovered the same snipers were shooting both sides in that rebellion . I think Russia had to take the Crimea back because I suspect that is where their power is located that they would need to control the Black sea .if someone would try to attack Russia like they did Yugoslavia Russia would want to control the Black sea . Why try to prevent Russia from selling gas ?

Rob JonesSaturday, September 27, 2014 at 5:43 am

As the Obama adm. is immoral at home, they are just as immoral in world affairs. I don’t think our venture back into the iraq area is any thing but a political sceme to garner more votes here at home.

bill stappFriday, September 26, 2014 at 10:00 pm

As soon as I saw Bill Gross TAKING a $200 million dollar salary over huge shareholder objections I knew he would fly the coup.You better reexamine that Weiss Janus rating.He is a narcissist and will screw up Janus eventually.

Tom MFriday, September 26, 2014 at 10:10 pm

My take on junk bonds: a lot depends on why you are invested in them. In my case, I have a significant amount invested in a “conservative” junk bond fund, primarily for the monthly income it throws off. During the darkest time of the past few years, the fund’s value dropped as much as 40% (it has since recovered, and then some), but my monthly income never fluctuated more than 5-10%. I can live with that. As long as you are in it for the income, invest conservatively, and can live with fluctuations in market value, I think junk bonds STILL deserve major consideration in an income-oriented portfolio (i.e. for retirees).

Karl ShafferFriday, September 26, 2014 at 11:24 pm

Bonds are a leading indicator for the stock market. Just look at 2007 and what followed. Batten the hatches: we are in for a rough ride!

Rob JonesSaturday, September 27, 2014 at 5:38 am

If indeed these are the end times the natural gas coming from the reserves that israel own could indeed be the touch stone that erupts end time prophecies. These have much to do with russia and the very area engulfed in a natural gas struggle.
Russia will not take it kindly if israel is taking a portion of it’s economic strangle hold on european markets away. And Israel certainly has a plentiful supply.

HowardSaturday, September 27, 2014 at 7:42 pm

Hi Mike
On Friday 26th September, I reduced my exposure to risk by $1,000,000 and will now wait until I know what the hell is going on. The end of QE may give some more clues. Some of us read the tea leaves and others just drink the cool aide, but what ever your choice it is soon going to get interesting.